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The Private Equity Asset Class

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Wilmington University - MBA Finance 2008

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Running head: The Private Equity Asset Class

The Private Equity Asset Class

Investment Rationale, Valuation Exercise & Modern Financial Techniques

Wilmington University

Student: Hedi Chaabouni

MBA Finance

Instructor: Mr. John J. Bish

February, 22, 2008

Table of Contents

Acknowledgments Page 3 / 102

Introduction Page 4 / 102

Part I- The Rationale behind Private Equity financing Page 8 / 102

Chapter 1: PE Asset Class Page 10 / 102

Chapter 2: PE Value Chain Page 17 / 102

Chapter 3: PE Strategic Power Page 31 / 102

Part II- Private Equity and Valuation Page 42 / 102

Chapter 7: PE Value Chain & Valuation Page 44 / 102

Chapter 8: PE & Value Based Management Page 47 / 102

Part III- Modern Financial Techniques & Private Equity Page 55 / 102

Chapter 9: Portfolio Theory in PE Page 57 / 102

Chapter 10: Risk Management & Financial Engineering in PE Page 62 / 102

Chapter 11: International Financial Management in PE Page 67 / 102

Conclusion Page 74 / 102

Appendixes: Cases in Emerging Markets

Appendix 1: Emerging Market Definition & Risk Profile Page 75 / 102

Appendix 2: DCF Valuation in Emerging Markets, the SPAM model Page 78 / 102

Appendix 2: A Case Study in Emerging Markets Page 92 / 102

References Page 102 / 102


I would like first to thank my finance instructors at Wilmington University who devoted time to teach me the concepts I need to become a well enlightened finance student. I especially thank Mr. John J. Bish for having taught me what the price of everything is; with his insight he gave me the keys to the secrets of finance.

I especially thank Mr. Aziz Mebarek, cofounder and managing partner at Tuninvest, a Private Equity firm with whom I made my first steps in the field in 1997 as a member of the board of a family business this investment firm invested in. With his unique insight, he inspired me and insufflated in me the passion for the Private Equity industry. He also gave me some feedback about his emerging market experience that helped me bridge the gap between theory and practice when writing this thesis.

Finally, a part of my acknowledgments goes to Mr. Majdi Chaabouni, a family member, today a top executive at a leading Arab bank in the Middle East. He is the one behind my dynamic of finance studies and English language graduate education. He taught me to go beyond my limits and passed me the passion of writing.


In this recent time where Private Equity funds are thriving globally and becoming a very serious alternative and sometimes a «trendy» way to raise money and finance industrial operations and business acquisitions, I thought that a contribution to an open debate in a somewhat close financial industry would be an interesting and healthy endeavor for the educational and business communities. Indeed, many formal books already exist on Private Equity; they describe the investment process from A to Z and the different types of transactions that could take place in terms of timing, type and size of the company invested in.

Yet, my interest in the industry made me wander in spaces I never intended to visit. This year, when performing my MBA Finance, I first started working on some papers related to Private Equity and found that each paper was somewhat related one to the other. From this fact stemmed the idea of a thesis encompassing several related articles describing and outlining the hot topics today debated around Private Equity.

The first draft of this thesis was therefore entirely dedicated to explore what issues matter today in the industry, and what is the rationale behind PE investments. Its purpose was then to answer questions about PE specific hybrid nature, the reasons behind its phenomenal returns and the breakdown of its value chain, and how this type of investment has gained an indisputable power amid other financing tools.

But after a while and this thesis continuing germinating in my mind, I found these issues to be just a starting point and decided to push the reflection further and try to explore new fields in the industry by broadening the traditional scope of discussion about Private Equity. I had my part one for this thesis but what about the rest?

As the valuation concept and techniques are at the core of the Private Equity process I decided, with the advise of my finance instructor, to devote the whole second part to it. After all, neither value chain, nor strategic power, exists without a sound valuation process and techniques. Valuation being an important part of my finance curriculum, this academic thesis aiming also to encompass all the concepts I touched on in my MBA program, it was natural to describe and analyze this concept from the beginning.

As and when I kept touching on new subjects and topics in the finance courses I'm actually taking, many other questions arose in my mind about the structure of Private Equity. Issues like modern portfolio theory or risk management and the use of derivatives within PE funds fully retained my attention. What if a PE fund applies some of the principles of portfolio theory a mutual fund uses? And what if a PE fund starts using derivatives to hedge a stake acquired in a privately held business? Obviously, in Private Equity today, these are not conventional practices. Nevertheless, many unconventional practices in the past time became conventional today after researchers and practitioners gained footings in spaces formerly recognized insurmountable. Here came the idea of the last part of this thesis which I call the prospective technical part. Its purpose is dual: first to start a reflection on the practice by the PE industry of modern financial techniques today widely used in financial markets, and second to dig in some technical aspects Private Equity is nowadays exposed to as international investing.

Finally, an appendix part is devoted to study a specific and today topic in economy and finance, the emerging markets. The choice to tackle the emerging market issue is probably dictated by my belonging to a country and region classified as so. In this part, the emerging market definition and risk profile are reviewed, and a Discounted Cash Flow Analysis valuation technique specifically applied to emerging markets is highlighted and deeply explained.

View differently; this PE thesis is tackled through four different and complementary angles. First, the rationale driving the industry is deterred to reveal the reasons behind the value creation engine in PE; second a closer look is given to valuation and how its process and techniques impact PE process; third modern financial techniques are cited to explore new and unconventional scopes in PE daily management, and finally the merging market issue in economy and finance is highlighted. The objective of this thesis is hence to make readers better grasp the Private Equity industry practice and challenges and in the same get acquaintanced with a today hot topic on the global business place: the emerging markets.

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